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Governance : Reforming the Income-Tax Act

The tax system of a country needs to be tailored in accordance with the state of society, economic composition of taxpayer groups, stability and efficiency


IN an era of voluntary compliance under the Income Tax Act, 1961, where nearly 99 per cent of income-tax returns are being accepted without any scrutiny, the tax law has to be simple, easily understandable and concise for compliance regarding disclosure of incomes and payment of tax. For this, the tax law, rules and returns, to be filed, need to have the above stated attributes. But, successive governments, including the present one, do not seem to believe in this thinking. Each year’s Finance Act add, modify and replace the sections of the IT Act in a big way as could be seen from the following numbers of clauses in the Finance Bills for the last four years (see table).
Besides the changes in law, substantial changes each year are made in the IT Rules also, whose number too has grown large with so many annual changes.

The IT Act was enacted in the year 1961 with 298 sections. It had, on March 31, 2016, 745 sections though the number shown in the IT Act continues to be 298. If the changes made by the 2017 Finance Act are also considered, the number will go above 800! The growth is made by adding alphabets to the main section such as ‘QQA’ (in section 80), HHBA in section 80 and BBDA in section 115, etc.

The efforts towards simplification got blunted because of the personal ego of the UPA Finance Minister, Shri Chidambaram, who, instead of entrusting the work to an expert body, like Law Commission (the 1961 Act was drafted on the basis of the recommendations of this Commiss-ion) or to a specially constituted Commission for this purpose, headed by a Judge of the High Court or Supreme Court, with members from various disciplines, like law, accounts, economics, tax policies, decided to get the Direct Taxes Code (DTC) drafted under his supervision by an In-house Committee of Tax Officers. This was a fatal decision.

For future, the tax changes, to be made, need to be divided in two parts–changes of a technical nature and amendments, requiring policy decisions with long-term impacts

Even after nearly eight years of work in the two terms of Shri Chidambaram, a simple, short, easy to administer DTC could not be enacted. In the budget speech for 2014-15, the present Finance Minister Arun Jaitley, was led to observe that the government will review the DTC in its present shape and take a view in the whole matter. Some suggestions of the Group were accepted and in the next year’s budget exercises, the idea to have a DTC drafted by Shri Chidambaram’s in-house team was dropped saying there is no great merit in going ahead with the DTC as it exists today. Since then, there is no talk about the reform and simplification of IT Act.

The tax system of a country needs to be tailored in accordance with the state of society, economic composition of taxpayer groups, stability and efficiency. There are certain basic aspects, which are to be kept in view in designing a tax structure or making changes in the existing law. These, briefly are [i] Simplicity; (ii) Stability; (iii) Equity; (iv) Controllability; (v) Neutrality; (vi) Elasticity/flexibility; (vii) Efficiency; (viii) Acceptability; (ix) Progressivity; (x) Ability to pay, etc.

The Meade Committee in UK, in its report ‘Structure and Reform of Direct Taxation’, published in the year 1968, has mentioned the following attributes of a sound tax system:

  1. A good tax system should be horizontally equitable.
  2. A modern tax system may be so construed as to be capable of vertical redistribution between the rich and the poor.
  3. There will be some clash between the criteria of economic efficiency (which requires low marginal rates) and of vertical redistribution (which will require higher average rate of tax on the rich); but a good tax system is one, which minimises this clash and permits a given redistribution with a minimum loss of efficiency.
  4. The final choice of re-distributional aims for a tax system involves basic value judgments about the nature of good society, which are matters for political decision(s).

There could be conflicts between various attributes. For example, all deductions and exemptions allowed in the individual income-tax law are intended to ease the burden of the tax and bring it more into line with the abstract and imprecise concept of ‘ability to pay’ and yet every deduction and exemption complicates the law. But, an efficient tax policymaker has to reconcile various conflicting considerations to design a good tax law.

SOME suggestions to achieve this are:

  • Entrust the work of re-designing of a new law to an expert committee as suggested earlier. The Committee need to work on a whole-time basis with adequate staff to give its report in 12 months and the IT law be re-enacted on that basis.
  • For future, the tax changes, to be made, need to be divided in two parts viz:-
    • Changes of a technical nature;
    • Amendments, requiring policy decisions with long-term impacts.
  • Technical changes are those arising from loose drafting, shortcomings coming to notice, inter-alia, on the basis of court decisions, softening the harshness of the existing law, changes, having short-term impacts, etc.
  • Policy decision changes are of a strategic nature, changing system of assessment; bring new concepts hitherto not existing like Dispute Resolution procedure regarding GAAR, retrospective amendments, etc.
  • Only technical amendments should be made through Finance Bills, barring those needing urgent action. The policy changes should be made through Amendment Acts after their examination by the Finance Ministry’s Committee’s examination, where necessary. In suggesting changes, the need for transparency amongst others like the following should be indicated: [a] What is sought to be achieved; [b] how it is proposed to be achieved; and [c] what would be the reaction to the proposed changes in the existing social, eco-nomic and political set up, men-tioning the relevancy of changes to be made.

In summing up, it could be said that changes in the IT Act need not be a ‘fate accompli’ for the country. The law should not be changed in haste and in ad hoc manner. Tax reform is a broader concept and has to aim seriously at improving the working of tax laws from the angle of taxpayers and tax administration on a long-term basis through efficient functioning of tax law. For this, the pre-requisites are the 8 Ps, viz. political will, purposive clarity, perspectives, perceptions, planning, patience and perseverance. The ad hoc exercises as are being done currently cannot be conducive to having a simple, efficient, revenue yielding and easy to administer IT law.

The writer is former Chairman, CBDT

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